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Wednesday, November 30, 2005

No housing bubble in US, says OECD

In many OECD ountries real house prices have moved higher and for longer than in previous cycles. But in two-thirds of countries, including the United States, there is not a significant overvaluation problem, according to the latest OCED Economic Outlook, published yesterday.

A number of elements in the current situation are unprecedented: the size and duration of the current real house price increases; the degree to which they have tended to move together across countries; and the extent to which they have disconnected from the business cycle.

While concerns have been expressed in several quarters about high housing prices, the evidence examined here suggests that overvaluation may only apply to a relatively small number of countries. However, the extent to which these prices look to be fairly valued depends in good part on longer-term interest rates, which exert a dominant influence on mortgage interest rates, remaining at or close to their current low levels.

In terms of affordability, "household debt service burdens have generally been relatively stable", as lower mortgage rates offset
rising house prices. The "main exceptions" are Australia, the
Netherlands and New Zealand.

In 2005 price-to-income ratios exceeded their long-term averages by 40% or more in one-third (6 in 18) of the countries studied: the United Kingdom, Ireland, the Netherlands, Spain, Australia and New Zealand.

In Canada, Denmark, France and the United States, the run-up has been more moderate but these values still represent historical peaks.

However, the OECD point out that price-to-income ratios are not a good measure of overvaluation:

The ratio of prices to household disposable income by itself, however, is not a sufficient metric to evaluate housing affordability. Indeed, house prices do not appear to be linked to income by a stable long-run relationship ..possibly because the cost of carrying a mortgage has varied over time.

They then provide an alternative approach which compares the actual price-to-rent ratio with that based on the user cost of housing over the past ten years. This analysis concludes there was overvaluation in australia and five European countries:

In the countries with high real house price gains (the United Kingdom, Ireland the Netherlands and Spain) and in Australia (where very high real prices have more recently been edging down) and in Norway, actual price-to-rent ratios were noticeably above their “fundamental” levels in 2004, suggesting overvaluation.

Overvaluation on this basis is "not large" in France, Canada, Denmark, Sweden or New Zealand, and "absent altogether" in Finland and Italy. House prices 'look undervalued" in Japan, Germany and Switzerland. As for the United States:

In the United States, the “fundamental” price-to-rent ratio was above its actual level until 2000, the benchmark year. Since then, the series have moved together and the gap between them has been negligible. On this measure, there does not appear to be much of a case for overvaluation, at least at the national level.

That said, the chapter also includes a box on regional housing markets in the United States, which shows that some regions - especially California and Florida - suffer from "price overheating".

The OECD also add the important caveat that housing valuation and affordability estimates would look a lot worse if interest rates were to rise significantly:

However, the extent to which these prices look to be fairly valued depends in good part on longer-term interest rates, which exert a dominant influence on mortgage interest rates, remaining at or close to their current low levels.

I guess there must be some kind of difference between 'over-valuation' and 'hyper-overvaluation'. Perhaps it has something to do with the relative risk of a hard or a soft landing.

The interesting thing is what it has to say about the UK, Spain and Ireland. Watch out if you happen to be standing underneath.

My guess though is that this won't just crash under its own weight. I think it all needs a trigger. My guess is that at some stage or other Italy will provide the trigger. Then, first one out's a chicken, but last one out's a fool :).

Kinda funny reading this OECD report on the "non-housing bubble" here in April 2007. Looks like they missed their mark totally. As an American expat who just sold our homes in both the United States and Denmark last year right before the bubble began showing signs of tearing at the seems in both countries, we took the "exit stage left" approach and got the fuck out of both housing markets. Now my wife and I are patting each other on the back for getting out at the top of both markets and have invested our money in foreign currency markets, precious metals and energy stocks. We are currently renting a house for the first time in over 10 years and i would recommend anyone living in either northern Europe and especially the United States (most importantly the cities which have seen the biggest over-inflated housing price increases over the past 8 years). Unfortunately we have just begun to see the beginning of the long slide downward for houses in both Denmark and the United States. The Subprime debacle in the US has already started rearing its head but the true damage from this will not been seen until later this year. In Denmark houses have gone past stagnation and are starting to fall in value at around 10-15% in some areas in and around Copenhagen. Just recently the Danish governement has passed a low to allow 100 year mortgages which in my opinion is there way of keeping housing prices on the increase while only delaying the inevitable hard landing which they are most definately trying to prevent.

U.S. housing prices are substantially higher every 10 years (see census data), interest rates remain very low, and prices are a little lower. In 10 years, the average U.S. home may be $50,000 higher with much higher mortgage rates (e.g. 10%). So, it's a buyer's market.

It's important to look at both interest rates and inflation regarding home prices (some only take inflation into account), although there are other factors (e.g. income, investment, taxes, etc.). Thirty-year interest rates fell from over 15% in the early-'80s to below 5% in the mid-'00s. Also, inflation fell from over 13% in the early-'80s to slightly over 1% in the early-00s. The following are unadjusted percentage increases in U.S. median home prices every 10 years: 1940-50 150%; 1950-60 62%; 1960-70 43%; 1970-80 178%; 1980-90 68%; 1990-00 51%. Since 2000, the U.S. median home price has risen roughly 85%. Falling interest rates should accelerate home price increases, while disinflation should slow home price increases. If all the relevant variables are included, I doubt U.S. medium home prices rose substantially more in the 2000s than other decades.

It may be best to look at changes in monthly housing payments or income to housing costs. The U.S. Bureau of Labor Statistics compiled some data (links below):

"The material well-being of families in the United States improved dramatically during the 20th century, as demonstrated by the change over time in the percentage of expenditures allocated for food, clothing, and housing."

"It listed average annual household income at $750 in year 1901, with 9.5 percent of that amount earned by children, for an average family of 4.9 people. Of this amount, 79.9 percent was spent on food, clothing and housing. By 2002-03, the average American family earned $50,301 a year and statisticians no longer mentioned children as income producers. The average household had shrunk to just 2.5 people and only 50.1 percent of the annual income was spent on food, clothing and shelter. Based on the value of the dollar in 1901, 2003 households would be earning $2,282 a year in real terms or a three-fold increase over 1901 totals. Meanwhile, only 19 percent of Americans owned their own homes in 1901 compared to 67 percent in 2002-03. The number of single-person households has also grown steadily from 16.8 percent in 1960 to 29.5 percent in 2002-03."

"American families have never earned more income than they do now, according to a longitudinal study by the US Bureau of Labor Statistics which was released on June 30 this year. The study also said that American families have never spent less on necessities or enjoyed a higher standard of living than they do right now. This leads to one inescapable conclusion: American families have never had it so good."

The BLS data show U.S. real household income rose three-fold over 1901 totals. However, the average household shrunk from 4.9 to 2.5 persons. So, real per capita income may have risen six-fold. Also, there were many inventions, innovations, quality improvements, etc., since 1901, So, the rise in real incomes understate or don't reflect the rise in living standards. Moreover, other conditions improved, e.g. labor, environmental, infrastructure, etc.

Averages are a wonderful thing for politicians since they will make it appear that when two people are considered, one with an income of $1,000,000 and another with an income of $1,000, then average income is $500,500.

"The ratio of prices to household disposable income by itself, however, is not a sufficient metric to evaluate housing affordability." (OECD)

Don't ya just love the sotto voce 'by itself'; certainly, if I am paying cash with the inheritance from Uncle Billy the household disposable income doesn't enter as a concern for me. For the rest of us less fortunate you get a kind of gut feeling that the amount of income you have will probably have an impact on whether you can afford a house or not. Whether you can afford a house or not would seem to be intimately connected with housing affordability, duh, unless of course you're an overpaid OECD economist. Still, I suppose this has been true enough in the era of sub-standard mortgages and liar loans.

"One in five American houses had at least four bedrooms in 2005. That's up from one in six in 1990, despite shrinking families and increasing costs for construction and energy. American homes, on average, are nearly twice as large as those in many European countries, including Britain, France and Germany. Only Luxembourg comes close among European nations, with average homes about three-quarters the size of those in the United States. Among states with the biggest percentage of large homes, Utah was followed by Maryland, Virginia, Colorado and Minnesota."

It seems, most American households can rent a room or two if necessary, which also adds to investment value (along with other factors I stated above).

Moreover, the 10-year U.S. homebuilding boom (rather than housing boom, since the U.S. homeownership rate rose from 67% to only 69%) was largely driven by demographics. Most of the 80 million U.S. baby-boomers will still be "prime-age" (i.e. 35-54) for another five to 10 years (and the 55-64 age group is the second most productive group). So, demographics, prices, interest rates, home improvements, larger homes, financial innovation, income, employment, etc., suggest the U.S. homebuilding boom wasn't a bubble and may tail-off over the next decade.

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The new mortgage reforms will definitely have a significant impact on the housing market because many prospective homeowners
will not be able to meet the stringent income to mortgage payment ratio of 28% and heftier down payments. As a result we will see more renters.

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